Whitepapers
For hedging purposes, convexity risk is a very important driver of MSR hedge cost and effectiveness, but it is not necessarily an easy concept to grasp.
FAQ
Mortgage Servicing Rights (MSRs) are very interest rate sensitive, requiring constant monitoring and frequent hedge adjustments. Increasing MSR investment increases financial volatility. Therefore, UCM recommends using income generating financial hedges coupled with a robust recapture program to minimize volatility. UCM developed its proprietary program, HedgeCalc™, to guide its experienced traders in employing a dynamic strategy that maximizes net hedge performance.
UCM engaged a national accounting firm, beginning in 2006, to review its Controls Placed in Operation and report pursuant to AICPA SSAE No. 18. This annual “SOC 1” report supports UCM’s clients’ reliance on HedgeCalc™ and the surrounding controls while providing their auditors with a starting point for understanding the system and its control environment.
No. An MSR valuation process that uses a Static Cash Flow model can be effectively hedged, as long as the model can accurately measure the MSR Fair Value sensitivities to the various rate inputs. As a matter of fact, if a Static Cash Flow model is used to arrive at MSR Fair Value, then the MSR value sensitivities used for hedging should come from the same Static Cash Flow model, in our opinion. To run the MSR asset through a different model to measure the value sensitivities used for hedging introduces hedge ineffectiveness caused by model differences. So whether an OAS model or a Static Cash Flow model is used to arrive at MSR Fair Value, the hedge can be effective if the MSR Fair Value changes are predictable based on changes in market rate inputs; the MSR value sensitivities used for hedging are measured in the same valuation model that is used for Fair Value; and the valuation process is accurate, stable and tightly-controlled.
If this conservatism is carried over into production pricing, then production volumes and profits are depressed. UCM recommends reflecting the full value of MSRs in production pricing, maximizing both production volumes and margins.
In early 2006, the Financial Accounting Standards Board issued Statement No. 156, requiring initial bookings of MSRs at fair value and allowing an election to subsequently account for MSRs at fair value, rather than the lower of amortized cost or market.
No. UCM believes, and history has shown, that there can be serious conflicts of interest to both value an MSR portfolio and then hedge the resulting interest rate exposure.
